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Calendar Call Spread: A Neutral to Mildly Bullish Strategy

Heres a great option strategy to use if you have a neutral (sideways) or mildly bullish outlook on a stock.

This one lets the investor benefit from time decay, which is usually the very thing that wreaks havoc on most investors options.

And its a limited risk way to make money when a stock is going sideways, which is something that you simply cannot do in the actual stock itself.

Definition

A Calendar Spread (also known as a time spread or horizontal spread) is when you sell (write) an option in one month and buy an option with the same strike price but in a different, further out month.

Since the option youre writing has less time (worth less) and the one youre buying has more time (will be worth more), this can also be referred to as a debit spread as well.

You can do this with puts too  sell a put in a nearby month and buy the same strike in a further out month.

As you would expect, youd have a neutral to bullish bias with the calls and a neutral to bearish bias with the put.

You can also sell this strategy as well buy buying the nearby and selling the further out  but today, lets keep out focus on the long side.

Example

Lets use AMZN for this example:

Lets say you wrote the Jan. 265 call for 3.50 (collect $350)

And lets say you bought the Apr. 265 call for 13.00 (paid $1,300)

net cost (debit) is 9.50 or $950

Why would I want to do this?

The maximum potential loss is limited you what you paid for the spread  in this case $950.

The maximum profit if removed together would be the difference between the two option prices at the expiration of the nearby month.

Lets say AMZN closed below $265 when the Jan. options expired.

At expiration, the Jan. 265 call I wrote for $350 is now worth $0 (gain of $350)

The Apr. 265 call I bought for $1,300 might now be worth $1,200 (loss of -$100)

my calendar spread is now worth $1,200

_________________________________

$1,200 less my cost of $950 = profit of $250 or a 26% gain on money invested

If I wanted, I could decide to hold onto that further out call if I thought a rally was underway  and make even more money.

But of course, if it went down, I could lose the rest of the premium. But again, my maximum loss would be limited to the price paid for the spread.

This is a great strategy, especially if you did this with out-of the-money options and the stock climbed up to the strike price by the expiration of the nearby option month. In this case, youd make even more money because the short call would expire worthless (meaning youd keep the entire premium as in the example above), but the long call, which is now at-the-money, would have likely increased in value, giving you an even bigger gain as both options would have been profitable.

Granted, youre still limited in your profit potential, but youre capitalizing on the dynamics that the nearby month will lose its value (time value) quicker than the further out one.

Some people probably dont bother with this strategy because the profit potential seems small. But if you look at it in percentages, a 10%, or 20%, or in this case a 26% return isnt small at all for one trade. And if you put five of these on for example, before commissions, that would cost $4,750. If you made $250 profit on each one, thats a $1,250 profit.

And thats pretty exciting.

You can learn more about different option strategies by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

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